The Effect of Risk Management on Financial Performance of Islamic Banks in Kenya

Abstract

Risk management is integral to a bank’s operations. It involves integrating risk management practices into the processes, systems and culture of the institution. Financial institutions face increasing pressure from various stakeholder groups to effectively manage their operational risks and to report their performance transparently across such risk management initiatives. This study therefore sought to fill this gap by establishing the effect of risk management on the financial performance of Islamic banks in Kenya. The objective of this study was to assess the effect of risk management on the financial performance of Islamic banks in Kenya. The study used a descriptive research design. The target population was seven commercial banks offering Islamic Banking in Kenya. For the purpose of this study the researcher focussed on the two fully fledged Islamic banks in Kenya and five commercial banks offering Islamic banking products. Census technique was used to include all the seven banks practicing Islamic banking. The researcher used secondary data which was obtained from the published annual reports spanning five years (2010 - 2014) for the Islamic banks and conventional banks with Islamic windows in Kenya. In analysing the quantitative data, the study used descriptive statistics using Statistical Package for Social Sciences (SPSS Version 18.0). The multiple regression analysis was used to determine the significance of each study’s independent variable in affecting the financial performance of Islamic banks in Kenya. From the findings the study concludes that risk management positively influenced the financial performance of Islamic banks in Kenya, as it was found that there was a strong positive relationship between risk management and financial performance of Islamic banks in Kenya. The study also found that there was a negative relationship between credit risk, insolvency risk, interest rate sensitivity and financial performance of Islamic banks. Thus the study concludes that credit risk, insolvency risk, interest rate sensitivity negatively affect the financial performance of Islamic banks. The study also revealed that there was a positive relationship between capital adequacy, size of the banks, operational efficiency and financial performance of Islamic banks. Thus the study concludes that capital adequacy, size of the banks, operational efficiency positively influences the financial performance of Islamic banks. The most significant factor is credit risk. Overall credit risk had the greatest effect on the financial performance of Islamic banks in Kenya. The study recommends that there is need for the Islamic banks to effectively manage their risk as it was found that risk management positively influences financial performance of Islamic banks. There is need for the management of Islamic banks to constantly check their banks’ exposure to credit risk, insolvency risk, interest rate sensitivity, as it was revealed that credit risk, insolvency risk, interest rate sensitivity negatively affect the financial performance of Islamic banks. There is need for the for the Islamic banks to enhance their capital adequacy, size of the banks and operational efficiency, as it was revealed that capital adequacy, size of the banks and operational efficiency positively influence the performance of Islamic banks.